Chinese Insurer Warns Of "Mass Defaults, Social Unrest" Due To "Mass Redemption" Run

One month ago, China came "this close" to the one event which terrifies Beijing more than anything: a run on China's shadow banks.

As a quick reminder, 150 customers of China's Mingsheng Bank, the country's largest private bank, were furious in mid-April when they learned that some 3 trillion yuan invested in Wealth Management Products, the backbone of China's shadow banking system, had vaporized after bank employees had engaged in fraud and embezzled the funds without ever investing it (later it emerged that Mingsheng employees had put the money into “cultural relics” and jewelry, for their own use).

And while fraud and embezzlement are both endemic in China, the bigger concern raised by the article was the threat of a bank run across China's massive and unregulated, nearly $10 trillion shadow banking system. Indeed, while there have been numerous allegations and warnings that China's entire shadow banking facade, dominated by WMPs and other "investment products", is nothing but a giant ponzi scheme in which recoveries - should there be a bank run, a topic recently discussed on Bloomberg - would be non-existent if there is ever a bank run, defaults of WMPs issued by big banks – and this case an unapproved WMP – are rare, as are shadow bank runs.

For now.

However, in a stunning announcement made by one of China’s largest insurers, Foresea Life has warned of "mass defaults and social unrest" unless China's regulator lifts a recent ban on its issuance of new products. In a letter to China’s insurance regulator, first reported by the Financial Times, Foresea Life Insurance which is a heavy investor in WMPs, has warned that the company expects "redemptions" of 60 billion yuan, or $8.7 billion, this year and might be unable to meet payouts unless it is able to sell new products.

Jut so there is no confusion, this is the definition of a ponzi scheme, and now that it has been so explicitly framed the result could be even greater redemptions, i.e., "bank runs" across companies that invest in WMPs.

Foresea's displeasure is linked to a December decision by the China Insurance Regulatory Commission (CIRC), which banned Foresea for three months from applying to sell new products. Two months later, in February, the agency banned Foresea chairman Yao Zhenhua, China’s fourth-richest man, from the industry for 10 years.

Questions about potential fraud at the company have remained unanswered, however the life insurer which allocated billions to WMPs in pursuit of yield (what else) was all too vocal in a letter dated April 28, in which Foresea asked the CIRC to resume new product approvals “in order to avoid inciting mass incidents by clients and localised and systemic risks, producing greater damage to the industry”. According to the FT, the term “mass incidents” is commonly used in China to describe demonstrations, protests and riots. It was also used by Hank Paulson in 2008 when demanding a blank check from Congress threatening the US with widespread panic unless the US banking sector was bailed out.

That this warning has now moved to Chinese users of shadow banking is troubling.

To be sure, this is not the first time a near-insolvent Chinese company has threatened with social unrest if it does not get a bailout. One month ago, China's - and the world's - biggest aluminum producer China Hongqiao Group demanded that both the Chinese Non-Ferrous Metals Industry Association and the Chinese government come to its aid, warning in its March 4 letter of “serious effects” if nothing is done, including “regional systemic financial risks” and “dramatic social unrest.” Yet while the fallout from one major commodity company would be largely contained, mostly to its own angry workers, the social panic and mass defaults resulting from the failure of China's $4 trillion Wealth Management Industry, would have far more dire implications.

Some more background on the troubled life insurer courtesy of the FT:

Foresea is a unit of Baoneng Group, a property and financial conglomerate that Mr Yao also chairs. Baoneng made headlines last year by attempting a hostile takeover of China Vanke, one of China’s largest residential developers. Baoneng has used the sale of so-called “universal insurance” products to finance its stake in Vanke and other listed companies. Such policies are, essentially, investment vehicles offering high yields and guaranteed payouts on maturities. Distributed through banks, they bear little resemblance to traditional insurance, which pays out only in the event of a risk incident such as death, illness, or accident.

The mass proliferation of such "shadow banking" products, largely as a result of deregulation of the insurance industry in recent years, has led to the sharp rise of universal insurance sales, which has helped groups such as Foresea and Anbang Insurance Group to grow. As a reminder, Anbang - which has a very questionable reputation - is also one of the most prolific acquirers of global corporations as it seeks to find high yielding targets for its "shadow" funds.

As the FT also notes, while Foresea’s premiums soared from Rmb32bn in 2014 to Rmb100bn last year they since tumbled 61% in the first quarter this year.

More troubling is that the date of Foresea’s letter indicates that, by late April, the regulator had not yet approved new Foresea products, despite the expiration of the three-month ban. In a statement on its website late on Wednesday, Foresea said that “the company’s operations are normal and its cash flow is stable”, adding that it earned Rmb1.4bn in profits in the first quarter. Needless to say, it wouldn't say anything else until it was too late (see Canada's Home Capital Group).

On one hand, the Chinese regulator's initiative to limit WMPs is a welcome change to the Chinese funding "wild west." It was observed in the latest PBOC monthly credit update, which revealed that for the first time in a decade, a key component of China's shadow funding, Entrusted Loans, declined.

The FT adds that in addition to Foresea, the CIRC has moved to contain universal insurance in recent months, amid President Xi’s call to curb financial risk. Analysts warn that the high yields offered by universal insurance force issuers to take risks in order to earn the returns necessary to meet promised payouts.

Many universal insurance products ostensibly carry long durations of five or even 10 years but the policies often include generous redemption terms, enabling investors to cash out of the products with minimal penalties.

Meanwhile, Foresea’s warning that "mass redemptions" could leave the group unable to meet payouts highlights the liquidity risk created by taking on short-term liabilities to purchase long-term, illiquid assets. In a further crackdown on China's unsustainable shadow banking system, in May the CIRC imposed a similar three-month ban on Anbang and accused the group of “wreaking havoc” in the market with aggressive sales tactics. The agency specifically criticized Anbang for selling products with short maturities.

On the other hand, however, while such a regulatory crackdown is long overdue, should the "shadow" funding of "insurers" like Foresea (and Anbang) be halted, the company - which by its own admission is a ponzi scheme - would disintegrate.

For now, however, it faces a more immediate challenge: what happens if Foresea is not granted regulatory relief as it demands? If the insurer is unable to resume issuance of its traditional shadow funding products, and should the "redemption run" accelerate, the company will have no choice but to eventually demand a PBOC liquidity injection or outright bailout. Considering how generous the Chinese central bank has been, this request will likely be satisfied.

But a far bigger problem, one which not even the PBOC would be able to contain, is what happens if accelerated "redemption" problems, currently limited to just Foresea, spread to the rest of the nearly $10 trillion shadow banking industry.

AIG had sold credit protection through its London unit in the form of credit default swaps (CDSs) on collateralized debt obligations (CDOs) but they had declined in value.[47][48] The AIG Financial Products division, headed by Joseph Cassano, in London, had entered into credit default swaps to insure $441 billion worth of securities originally rated AAA. Of those securities, $57.8 billion were structured debt securities backed by subprime loans.[47][49] As a result, AIG’s credit rating was downgraded and it was required to post additional collateral with its trading counter-parties, leading to a liquidity crisis that began on September 16, 2008 and essentially bankrupted all of AIG. The United States Federal Reserve Bank stepped in, announcing the creation of a secured credit facility of up to US$85 billion to prevent the company's collapse, enabling AIG to deliver additional collateral to its credit default swap trading partners. The credit facility was secured by the stock in AIG-owned subsidiaries in the form of warrants for a 79.9% equity stake in the company and the right to suspend dividends to previously issued common and preferred stock.[50][51][52] The AIG board accepted the terms of the Federal Reserve rescue package that same day, making it the largest government bailout of a private company in U.S. history.[53][54]

On March 17, 2009, AIG announced that they were paying $165 million in executive bonuses, prompting the AIG bonus payments controversy. Total bonuses for the financial unit could reach $450 million and bonuses for the entire company could reach $1.2 billion. President Barack Obama, who voted for TARP as a Senator[55] responded to the planned payments by saying "[I]t's hard to understand how derivative traders at AIG warranted any bonuses, much less $165 million in extra pay. How do they justify this outrage to the taxpayers who are keeping the company afloat?"[56] Politicians on both sides of the Congressional aisle reacted with outrage to the planned bonuses. Political commentators and journalists expressed an equally bipartisan outrage

The sad thing about China, is that the 'insiders' in China have already scalped all these investors, moved their families to San Marino California, and are living in their $5,000,000 home...right next to two others they paid cash for and are renting out...with their kids now receiving a FREE American education from the schools in San Marino and Pasadena. (minus property taxes)

Will China ever figure out how to clawback what these theives have taken from the hard working Chinese people?

ps. I know there's a lot of Chinese haters here...but there's nothing to hate about people who are willing to get up everyday and work their ass off 6 days a week. Those are the victims....and it's not their fault the oligarchs are making cheap junk...and it's CERTAINLY not their fault that American's can't seem to get enough of the stuff.

Wait till the plebs hoard all the cash, then claim counterfeit terrorists are the problem and render current yuan notes worthless. The Chinese are no better at this game than anyone else. If you hoard in gold then you escape this government fraud.

It kind of is their fault that Americans cannot get enough of the stuff because their leaders, whom they implicitly support, arranged this anticompetitive dumping behavior with American politicians by limiting consumer choice and then claiming the consumer "can't get enough."

When the wheels come off this cart...heads will fucking be rolling in the streets!

Do any of you people really think they captured so much of the world's manufacturing because they " do it better "? Bullshit. They build factories with money just handed out like water...and get labor from the masses of 3rd century villagers who have existed in the hinterlands as subsistence farmers.
Slaves...more or less.

Exactly, they control the markets until they don't. If they knew or saw whatever was coming, they would have adjusted their marketing to protect themselves. The problem is like anything, they are inside the system they are trying to control. And the only way you can see what is coming is to be outside of it.

The government should have immediately called for AIG to repay its public loans and caused them to go bankrupt. Instead, only outrage. And most assuradly they will give new public bailouts during the next crisis.

The whole Chinese Shadow Banking "spreading" fear is just that. fear. Chinese people always make their decisions completely independent of any other Chinese peer group and they never move in herds and are not candidates for any bandwagon theories of sociological behavior.

ps....for those who know NOTHING about Chinese people or the broader Asian mentality, I'll go ahead and put the requisite /sarc.

I half agree with you, but the bane of the insurance industry and the reason they are bleeding from their rectum, is because of ZIRP and NIRP. Interest rates are too low even for them. The Central Bank FIAT money, ponzi scheme scam is designed to allow the insurance industry to be one of the first to collaspe.

It's not going to be the banks who are going to lose their money is it? It is me and you who will suffer first. Thank god we have brilliant financial oversight and a political class that truly have the best interests of the plebs when they conduct politics and pass financial regulation. Just imagine where we'd be if this did not happen. We'd be fucked.

I seem to remember hearing a story where there was a problem on a big construction project, and the property owner was out for blood. The owner's lawyers had all the contractors and subcontractors (including the design professionals) in the room, and the first thing they said was "If you don't have insurance, raise your hand." Most of the small, independent guys raised their hands. The lawyers then said, "OK, you can go." No insurance meant no point in suing, because what could you expect to get from the person themselves: car payments, a mortgage, and a few grand in cash?

The Chinese bank ponzi is the big tipping point for the Canadian housing market. If it implodes (I say "if", because central banker antics seems to be endless these days), that's going to rip the wind out of the sails of the Canadian housing bubble...and probably a lot of other ones.